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Is deflation good or bad? Just mind the inflation gap

Author

Listed:
  • Marco Casiraghi

    (Bank of Italy)

  • Giuseppe Ferrero

    (Bank of Italy)

Abstract

We explain why the macroeconomic effects of shocks to inflation of the same size, but opposite sign, are not necessarily symmetric. All in all, the costs of deflation and disinflation tend to exceed those of inflation due to the presence of constraints in the economy, namely the zero lower bound on nominal interest rates, downward nominal wage rigidity and borrowing limits. When these constraints are binding, they can prevent monetary policy from closing the inflation gap, labor market from clearing and agents from deleveraging. The impact of a disinflationary shock on the tightness of these constraints depends on the cyclical and structural conditions of the economy. We argue that it would be a mistake to assume that perverse effects can arise only with actual deflation and thus that the classification of deflationary episodes into good (supply-driven) and bad ones (demand-driven) is not only incorrect, but also misleading in terms of policy implications. Empirical evidence for the euro area suggests that the three constraints have become increasingly tight recently.

Suggested Citation

  • Marco Casiraghi & Giuseppe Ferrero, 2015. "Is deflation good or bad? Just mind the inflation gap," Questioni di Economia e Finanza (Occasional Papers) 268, Bank of Italy, Economic Research and International Relations Area.
    • Handle: RePEc:bdi:opques:qef_268_15
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    File URL: https://www.bancaditalia.it/pubblicazioni/qef/2015-0268/QEF_268.pdf
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    References listed on IDEAS

    as
    1. Andrew Filardo & Claudio E. V. Borio, 2004. "Back to the future? Assessing the deflation record," BIS Working Papers 152, Bank for International Settlements.
    2. Stefano Neri & Alessandro Notarpietro, 2014. "Inflation, debt and the zero lower bound," Questioni di Economia e Finanza (Occasional Papers) 242, Bank of Italy, Economic Research and International Relations Area.
    3. Gauti B. Eggertsson & Paul Krugman, 2012. "Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo Approach," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 127(3), pages 1469-1513.
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    Cited by:

    1. Stefano Neri & Giuseppe Ferrero, 2017. "Monetary policy in a low interest rate environment," Questioni di Economia e Finanza (Occasional Papers) 392, Bank of Italy, Economic Research and International Relations Area.
    2. Stefano Neri & Stefano Siviero, 2019. "The non-standard monetary policy measures of the ECB: motivations, effectiveness and risks," Questioni di Economia e Finanza (Occasional Papers) 486, Bank of Italy, Economic Research and International Relations Area.
    3. Giuseppe Ferrero & Massimiliano Pisani & Martino Tasso, 2022. "Policy Mix During a Pandemic Crisis: A Review of the Debate on Monetary and Fiscal Responses and the Legacy for the Future," Springer Proceedings in Business and Economics, in: Luigi Paganetto (ed.), Economic Challenges for Europe After the Pandemic, pages 267-320, Springer.

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    More about this item

    Keywords

    monetary policy; unconventional monetary measures;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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